Everything You Need To Know About Janet Yellen

By Evan Schnidman

 

When the internet erupted with commentary about President Obama's official selection of Janet Yellen to be the next Fed Chair, I deliberately decided to write about the largely overlooked FOMC minutes released an hour before the President's press conference. Now that a few days have passed, I am going to distill down the important points about Dr. Yellen's appointment.

Personality

Although this is not usually touted as a key trait for a leader of a technocratic organization, I suspect Dr. Yellen's personality and notoriously diligent work ethic (in economic circles she if often referred to as a "rigorous thinker") will play a key role in her leadership style. Writing specifically about her humility, University of Michigan economics Professor Justin Wolfers said:

I remember being a visiting scholar at the San Francisco Fed when she was president of the bank. Typically, Fed presidents remain safely cloistered in the executive offices, away from the great unwashed. Not Janet. It wasn't unusual to see her in the cafeteria, tray in hand, looking for a table of friendly economists to join. She had an enviable ability to make even the most junior staffers feel at ease and valued.

I suspect this humility will not only allow Dr. Yellen to relate to the common man affected by Fed policy, but also to her staff and colleagues on the Board.

Leadership Style

Aside from the personality traits that will undoubtedly impact her leadership style, the two most important leadership traits Dr. Yellen possesses are her skills as a consensus builder and her willingness to embrace conflict when necessary. Both of these skills contrast from Chairman Bernanke, although he has proven himself to be a reasonably good consensus builder.

Writing specifically about her consensus building skills, Bloomberg News stated:

In spite of her identification as a leading dove, Yellen has shown an ability to forge consensus with the more hawkish, anti-inflation members of the Federal Open Market Committee -- a quality that could come in handy as the central bank wrestles with when and how to unwind all the stimulus it has pumped into the economy.

This statement was followed by the observation that Yellen has gone out of her way to meet with Fed district bank presidents on a number of occasions.

Yellen's calendars, obtained under the Freedom of Information Act, show more than 90 meetings by phone or in person with Fed district bank presidents in 2011 and 2012, when she visited the Boston, New York, Philadelphia, Atlanta, Cleveland, Chicago, Minneapolis and San Francisco.

While Dr. Yellen's consensus building skills have been reasonably well reported for several months, the more interesting point about her leadership style is undoubtedly her assertiveness, as reported by The New York Times:

Ms. Yellen is also a more assertive leader than Mr. Bernanke and appears less averse to conflict. While both encourage open debate and seek to make decisions by consensus, Ms. Yellen has been a more vocal and persistent advocate for her own views. Mr. Bernanke has allowed Fed officials to air their views freely, while Ms. Yellen has expressed concern that the cacophony undermines the Fed's effectiveness by sowing confusion about the direction of policy.

The New York Times article went on to explain Dr. Yellen's willingness to challenge the Maestro himself, Alan Greenspan:

Ms. Yellen was the rare Fed official to challenge Mr. Greenspan and succeed. In 1996, she marshaled academic research, including a paper she had encouraged Mr. Akerlof to write, to argue that the Fed should seek to moderate inflation rather than eliminate it. The research showed that a little inflation helped to minimize unemployment. Employers that were reluctant to impose wage cuts could instead allow inflation to erode the real value of wages, allowing them to reduce labor costs.

The Times article continued by pointing to Yellen's role in building internal support for the explicit 2% inflation target (a move with which I disagree). Perhaps more important, the article also quoted Peter Orzag referencing Dr. Yellen's "rigorous" thought process in a veiled reference to Brad Delong's point that Dr. Yellen would be an excellent Fed Chair in normal circumstances, but perhaps not as good in a crisis where creative policy decisions must be made quickly. Orzag said:

I could see why people believe she's particularly good at situations in which there are important decisions to be made that involve pulling facts and weighing consequences carefully without pulling the trigger right away.

Policy Focus

Stepping away from the personality and leadership traits of Dr. Yellen into the more important policy issues. One thing is very clear about how a Yellen Chairmanship will unfold: communication is key. As Tim Duy systematically evaluated, the Fed's existing communication policy is confusing and lacking strategic vision; it needs improvement. Given that Dr. Yellen has been the head of the communication subcommittee at the Federal Reserve Board for the last couple years, she certainly knows more about the existing strategy than anyone else and has played a bigger role in expanding communication over the last couple years than basically any other individual in Fed history. However, that does not mean she is the best person to improve the Fed's communication strategy.

In recent months she has been in almost open dispute with Fed Board member Jeremy Stein who has suggested that communication can have a magnified effect and thus induce market volatility in the form of wider rate spreads. This led Stein to advocate for tapering the Fed's asset purchases sooner as opposed to later. Although the Yellen camp obviously won this argument at the September FOMC meeting (with Stein also voting to sustain the current pace of asset purchases), the market (over)reaction to talk of tapering and the ensuing dispute between Yellen and Stein highlights the need to more tightly manage Fed communication.

Perhaps Dr. Yellen's more "assertive" leadership style (than Chairman Bernanke) will serve her well in managing communication, but it is also important to note that modern Fed communication is more complex than ever before. For instance, in highlighting the difficulty in managing forward guidance, Felix Salmon writes:

…it's one thing for a Fed chairman to rally his FOMC troops and get them all to agree on a certain course of action at a certain meeting. It's another thing entirely to try to get those troops to agree to a future course of action, stretching out as far as mid-2015, despite the fact that no one really knows what the economy is going to look like then.

Salmon suggests that Yellen manage the cacophony not by squelching out dissenting voices, but by embracing them. He suggests that Dr. Yellen make it clearer than ever before that FOMC members disagree, but that policy is going in a particular direction based on committee consensus. While I like this strategy in theory, I think it would be very hard to manage in practice and runs the risk of diminishing Fed credibility the way the Supreme Court has diminished their own with so many 5-4 decisions. It is far more likely that as Chairman, Janet Yellen will limit communicators to stay on point in an effort to provide a clear signal about monetary policy.

Global Market Response

Thus far the global market response to the Yellen nomination has been pretty subdued. Developing markets responded favorably to the prospect of continued stimulus, but with a little trepidation about the possibility of a weaker dollar. Perhaps more important is the unrelated economic event of two of America's biggest trade partners, Europe and China, signing a currency swap deal. This marks a major step toward the Chinese Yuan becoming a global reserve currency. Although the timing is largely coincident with the Yellen nomination, this move is likely associated with perceived global weakness in the stability of the dollar due to the impending debt ceiling breach. It will be Chairman Yellen's job to ensure that the dollar remains a global reserve currency, despite the fiscal and monetary ramifications of strife between the Legislative and Executive branches.

Aside from the long term prospect of managing the dollar abroad, Dr. Yellen has already had an enormous impact on global central banking. In India, new central banker Raghuram Rajan has already followed Dr. Yellen's steps with an implicit inflation target. Similarly, Bank of England Governor Mark Carney has pursued an aggressive communication policy, similar to the one Dr. Yellen has advocated since rejoining the Fed in 2010. Perhaps the only dismissal of Dr. Yellen's policy proclivities comes from Chairman Bernanke's graduate school adviser and former head of the Bank of Israel, Stanley Fischer. Dr. Fischer has suggested that forward guidance and the plethora of other new communication policies confuse markets and run the risk of diminishing central bank credibility. While I do not expect this view to sway Dr. Yellen, it is worth revisiting to see if she at least manages the forward guidance strategy more precisely.

Hawk or Dove?

While the media narrative has consistently categorized Dr. Yellen as a dove, I think this is not completely fair. In the 1990s she expressed hawkish inflation views about the dangers of asset bubbles, and although slow to repeat these concerns in the 2000s, she was still ahead of the curve in spotting the crisis on the horizon. Perhaps more important than her individual past is the history of other Fed Chairmen. Specifically, new Fed Chairs have historically been quick to raise interest rates and tighten policy in order to establish their credibility as an inflation fighting central banker. To be fair, economic cycles have lent themselves to this pattern, but the pressure to establish credibility is definitely there. Nevertheless, I suspect the pressure on Dr. Yellen will be more towards generating continued job growth since inflation remains low and stable and her challenge appears to be persistently high unemployment.

Conclusion

Will all of the commentary, anecdotes and other information available about Janet Yellen, I think it is exceedingly unlikely that markets will be surprised by her leadership style or policy outcomes. So, investors and traders should expect an extension of the Bernanke years in terms of loose policy designed to stimulate job growth, but investors might also be pleasantly surprised (and traders slightly dismayed) by a tighter and more carefully managed communication strategy that avoids undue market confusion and increased volatility.

A testament to the resilience of markets: World stock market capitalization is nearly back to pre-recession, pre-crisis levels

By Carpe Diem

 

The Paris-based World Federation of Exchanges (WFE), an association of 58 publicly regulated stock market exchanges around the world, recently released updated data on its monthly measure of the total market capitalization of the world’s major equity markets through the end of September. Here are some highlights:

1. As of the end of September, the total value of world equities in those 58 major stock markets reached $60.7 trillion, the highest monthly world stock market capitalization since October 2007, several months before the global economic slowdown and financial crisis started and caused global equity values to fall by more than 50% and by almost $34 trillion  (see chart above).
2. The total value of global equities increased by $3.3 trillion from August to September, which is the sixth largest monthly gain in world equity values in the history of WFE data back to 1995.
3. Compared to a year earlier, September’s world stock market capitalization increased by 14.8%, led by a 18.6% gain in the Europe-Africa-Middle East region, followed by gains of 13.6% in the Americas and 13.1% in the Asia-Pacific region.
4. By individual country, the largest year-over-year gains were recorded in Greece (117%), Argentina (58%), Ireland (41%) and Japan (31%). In the US, the NYSE capitalization increased by 20.4% and the NASDAQ by 15.3%. The biggest losses in equity value over the last year were posted in India (-19%), Peru (-18.2%) and Egypt (-17.9%).
5. The September world stock market capitalization of $60.7 trillion was the second highest level in history and was just 3.3% below the pre-recession peak, and all-time record high of $62.8 trillion of global equity values in October 2007

Compared to the recessionary low of $29.1 trillion in February 2009, the total world stock market capitalization has more than doubled (increase of 109%) over the last 4.5 years to the current level of $60.7 trillion, recapturing almost all of the global equity value that was lost. The global stock market rally over the last four years has added back more than $31 trillion to world stock market values since 2009, and demonstrates the incredible resiliency of economies and financial markets to recover, even following the worst financial crisis in generations.

An Honest Letter from the Chairman of General Motors

By Porter Stansberry

Wednesday, October 2, 2013

 

Dear shareholders,

Moody's Investors Service recently upgraded General Motors' rating.

The major credit-rating agency bumped our rating from Ba1 to Baa3 – its lowest tier of "investment grade" credit.

Nobody was more surprised than me. Let me tell you plainly, I do not believe our company is an investment-grade credit. Nor are our operations likely to improve in a way that would have led any reasonable analyst to conclude such. That is why all of the other major ratings houses (S&P, Fitch, Egan Jones) continue to rate our corporate obligations as "junk" – speculative debts that have a significant risk of default.

I now understand what Bill Gross means when he says investors shouldn't trust Moody's ratings because the company has become a de facto arm of the U.S. government. Or as he put it recently: Moody's and the U.S. Treasury are just one big "happy family."

Gross manages hundreds of billions of dollars in private capital for the investment management firm PIMCO. So he has the luxury of being able to say whatever he wants in public.

I don't have that luxury. I'm the chairman of a publicly owned corporation, whose debts are soaring, whose margins are collapsing, and whose capital structure is still controlled by the government and our unions. So when the reporters called me to ask about the Moody's upgrade, I said: "Good things happen when you build great cars and trucks and deliver strong financial results."

It's a great line. It still makes me chuckle.

Read it carefully. You'll notice… I didn't say anything about GM.

What I couldn't say is that our business is already beginning to collapse, again. Look at our core automotive operating profits. In the first six months of 2012, we generated $2.8 billion in automotive operating profits. In the first six months of this year, we made a little more than $2.1 billion. Thus, our core, global automotive business has seen its operating profits decline substantially… by more than 24%.

We are approaching another crisis at GM, one that has its roots in the bailout of 2008/2009. The faulty bankruptcy process caused this crisis by failing to address our largest obligations (pensions and retired employee health care). And the crisis results from the motivations of our government owners – motivations that do not square with capitalism.

Like my predecessor, Rick Wagoner, did… I plan to write to you from time to time, privately, here in these pages. I will tell you what is actually happening with our great company – an institution that was once the largest privately financed endeavor in human history. You'll get the truth here, even if I'm not allowed to say it anywhere else…

What's happening with GM is a microcosm of what's happening with the rest of our society. Where once we sought only a fair opportunity for greatness, now we seek the false security of collectivism. I see it happening right in front of me every day.

I believe an honest discussion of what's happening with our business could help educate the public about the failure that's inevitable when resources – like our capital, plants, and people – are governed by politics rather than by markets.

At GM, we abandoned capitalism in 2010 when we emerged from bankruptcy. Instead of treating all of our creditors fairly, we gave the lion's share of the company's assets to the federal government and the UAW health care trust. Meanwhile, we didn't do anything to mitigate our enormous pension liability, which today stands at $26 billion. At the end of the bankruptcy process, none of our 400,000 retired workers lost a nickel. On the other hand, our shareholders, creditors, and many of our suppliers were wiped out.

That's not the way capitalism is supposed to work. And still today, GM isn't really privately owned. Instead, the company is a kind of public-private "partnership," where actual control rests with the government. Today, GM is more like a Ponzi scheme than a real business.

How so? Ponzi schemes don't generate any actual profits. They require greater and greater sums of money to work. Sooner or later, there simply isn't enough capital available to maintain the mirage of a functioning business. That's exactly what's happening at GM.

Don't take my word for it. Consider the facts below. Then, decide for yourself.

Is GM a real business, owned by capitalists, driven to create real profits, to be shared by its owners as they see fit? Or is it a kind of elaborate, government-sanctioned scheme, meant to enrich a few chosen, special interests?

PART I: Who Are the Real Owners?  All of Our Profits… and More… Are Going to Retired Workers
Since GM emerged from bankruptcy protection in mid-2010… we've done great.

The last few years are the best years in the history of our company. We've never built better cars. The market research firm JD Power says GM has the highest-quality cars of any major carmaker. Our trucks, it says, compete with Porsche for the highest-quality vehicles made anywhere in the world. We've never generated more revenue. In total, we've made about $26 billion in operating cash flow – what our main business generated before paying capital expenses and similar costs – since we emerged from bankruptcy.

It all sounds good, I know.

The bad news is that our business requires massive amounts of capital to sustain its operations. These so-called capital expenditures consumed roughly $20 billion of those operating profits. That left us with roughly $6 billion-$7 billion in actual cash that we could, in theory, return to our true owners (our shareholders) or re-invest into profitable lines of business.

So where did this money – the so-called free cash flow – go?

All the money – and a lot more – went to retired workers, unions, and the government.

In total, we've sent around $18 billion in cash to these interests – far more than we've been able to earn. These payments started with $3.9 billion in dividends on special "preferred" shares the union, the U.S. Treasury, and the Canadian government got during the bankruptcy process. Keep in mind, our creditors got none of these shares, and we've never paid a cash dividend to regular, common stockholders.

Another $8.5 billion went to repay debts to the U.S. Treasury and the union, obligations that we were saddled with in bankruptcy.

And that's not all. In 2012, we announced with great fanfare that our operating results were so good, we were going to begin buying back shares. Normally, that's great for common shareholders.

But in this case, the $5.1 billion worth of stock we bought back ALL came from the U.S. Treasury. No former creditor or any other public shareholder was able to sell to us. That's not all… We paid a $2-per-share premium to the actual market price of our stock. We simply gave the U.S. Treasury another $400 million "gift" for allowing us to buy back the shares it held.

Remember… private investors didn't have a chance to sell their shares to GM at a $2 premium. That deal was nothing less than a crime. It was the U.S. Treasury stealing $400 million from the shareholders. If any other business in the country did something like this, it would get hit with a hundred lawsuits overnight. But when GM did it? The press cheered. How can you explain that?

So we continue to owe far more to unions and governments than we're earning. If that were our only problem, perhaps we could envision a light at the end of the tunnel. But these obligations are only the beginning…

That $26 billion in operating cash flow already accounted for about $8.8 billion in cash payments we made to support our pension plan and other retirement benefits. Without those obligations… our number would have looked even better, with operating cash flow of nearly $35 billion. That anchor around our neck isn't going anywhere.

In addition to the cash, we contributed in 2011 60 million shares of stock (worth $2 billion) to the pension plan. No, that wasn't a cash expense. But believe me, shareholders should wish it was, as the expense will end up coming out of their pockets, instead of ours.

Just think about what that means…

Instead of the workers supporting the shareholders… at GM, the shareholders are supporting the workers. Sounds a little bit like communism, doesn't it? Well, just wait. The nonsense is only getting started…

In 2012, we announced a big deal to eliminate our entire legacy, white-collar-salary pension obligations. We paid the Prudential insurance firm around $3.5 billion to manage $25 billion worth of our pension liabilities, taking them off our books. Don't forget… we also gave Prudential $25 billion from the pension fund to manage.

Think about that for a little while. When is the last time you had to pay your broker 14% of your assets upfront to manage your account? Hedge funds normally charge 2%. They're considered expensive. Paying 14% sounds a little steep, doesn't it? No one ever explained it to me, either. My guess is a lot of that fee ended up in union offices or political piggy banks.

Whatever happened, all of the money is gone. In the three years after bankruptcy, we made roughly $6 billion-$7 billion in "free cash flow." Somehow, that cash was supposed to cover $18 billion in obligations… including almost $1 billion a year in preferred-stock dividends to the union's health care trust and the Canadian government. That also includes the $400 million "gift" to the U.S. Treasury and the $5.1 billion worth of shares we bought from it.

And for our common shareholders, our real owners? We haven't paid a cent.

So who really benefits from our brands… our research and development… our decades of investment… and the tens of billions of capital we have at stake? Is it our shareholders? No, it isn't. It's the union. It's the retired workers. And it's the government.

Is any of this likely to change any time soon? No, it's going to get worse… a lot worse.

Look at our preferred shares. They were created to make sure the union got most of the value out of our remaining assets. (Our bondholders didn't get any of these preferred shares.) The shares pay a 9% annual dividend. Try to find any other preferred stock issued by a major corporation that pays a coupon that large. You won't find another example.

We were simply hijacked by the bankruptcy court and the Obama administration. And we have to pay this dividend before we pay anything else. If we don't, these obligations accrue, a situation that would rapidly warp our entire capital structure, placing the whole company in the union's control.

So one of my most important jobs is to buy back these securities as quickly as I can. The problem is, they're extremely expensive. I've just negotiated a deal to buy back 120 million preferred shares at $27 each from the union's medical trust. That's $3.25 billion. Believe it or not, the medical trust will still own 140 million of these preferred shares. The Canadian government also owns a few of these shares (16 million). We can redeem all of these remaining shares in 2014, but it will cost us almost $4 billion – in cash.

To pay off the union then, we'll have to borrow money… billions.

Now, you know the real reason why Moody's just raised our credit ratings. I'm sure the government told Moody's to help GM raise the money so we can pay off the unions.

Shall I feign indignation that the country's most politically powerful union is able to manipulate Moody's credit ratings?

PART II: Since Government Can't Let Automakers Fail, Overcapacity Is Getting Worse and Worse
I'm proud of GM's cars.

As I mentioned, we've made huge strides in increasing the quality of our vehicles. But guess what? So has every other carmaker in the world. The competition makes it harder and harder to make a profit.

Just look at our actual numbers. In the first six months of 2012, we sold $74.5 billion worth of cars around the world (automotive revenues). We made an operating profit of $2.8 billion. That's a minuscule operating profit margin of 3.8%.

The situation is getting worse. In first half of 2013, we sold $74.6 billion worth of cars around the world, fractionally more revenue. But we earned a lot less, only $2.1 billion. Our costs rose, and we could not pass these costs on to our customers. Our operating margin declined to less than 3%.

These are razor-thin margins. Margins this small are dangerous to operating companies, like ours, that have huge volumes. If anything were to happen to consumer demand – for example, if the economy were hit with a recession or we were unable to finance our customers (more about this below) – these puny margins would disappear overnight. The result would be sudden, large losses.

You should know: An "accident" like this is inevitable. It's going to happen. And it's going to happen soon. The auto industry suffers from a tremendous glut of capacity. According to different sources, 20%-30% of global production isn't profitable.

My counterpart at Nissan, Carlos Ghosn, is one of the few senior executives who has spoken honestly about this major problem. At a recent car show in Geneva, he said, "All of the car manufacturers have capacity problems – all of them."

Sergio Marchionne, the chief executive of Chrysler and Fiat and the president of the European Automobile Manufacturers' Association, estimates the auto industry needs to cut capacity in Europe by 20%.

Automakers employ or support 2.3 million people in Europe. Just like in the United States, the auto industry is too politically powerful to be allowed to fail. It's the same thing, all around the globe. So how likely is it that any automaker, anywhere, will be able to significantly reduce production?

Capitalists making tough, but realistic, decisions no longer control this industry. Instead all of the capital-allocation decisions are being driven by politics. Whether you call it "welfare," "socialism," or "communism" doesn't matter. As long as this continues, it's inevitable that GM's operating margins will continue to deteriorate. And that means, it's only a matter of time before we're dealing with huge quarterly losses.

Bernd Bohr is the head of the automotive group at Bosch, the privately held German company that's the world's largest manufacturer of car parts. He explains the current problems by pointing out that none of the major carmakers was allowed to fail in 2008/2009. "It was a peculiarity of the 2008-09 crisis," Bohr said, "that practically no capacity was taken out of the market due to state intervention…"

While hard to fix, the problem is easy to understand. As long as no carmakers are allowed to fail, the ability of the entire industry to earn a profit will be greatly compromised. GM is the largest car company in the world (roughly tied with Toyota). It has the highest labor costs. It is heavily burdened by its pension obligations. It has, despite my best efforts, several weak brands.

In this scenario, GM is extremely vulnerable, the most vulnerable large carmaker in the world.

My advice? Don't pay attention to our revenue figures. Watch our margins. It's overcapacity that will kill us this time, not quality or a lack of demand.

PART III: We're Doing It Again: Selling Cars to Unqualified Buyers
Think about the dead-end GM faces strategically.

We can't compete on brand. No one under 40 years old would rather drive a Cadillac than a BMW. Almost no one at any age would rather have a Chevy Malibu than a Honda Accord. And even though our trucks are great, Ford's are just as good (if I'm being honest).

We can't compete on price because we don't have the cheapest costs. Instead, we have the highest.

And no matter how much money we make, all of it (and more) will end up being siphoned off to either the union's health care trust or the pension fund.

What would you do in this scenario?

I've thought about this question every single day for three years. There's only one answer. And it's a lousy one.

GM will have to compete on credit. We'll have to work out a deal with Wall Street to borrow billions and billions and funnel the money to car buyers who the other makers won't lend to. Our only chance is to, once again, become too big to fail.

In the fall of 2010, we acquired a financial business, now called GM Financial. It exists to provide financing to buyers of our cars in dealer showrooms. You might recall that our company's last foray into finance didn't end well… huge losses at our former finance subsidiary were one of the primary reasons our company spiraled into bankruptcy back in 2008.

We're doing it all again.

As our margins have declined, we've attempted to grow by making more and more loans. Our loan book has ballooned to $11.5 billion. We made about 75% of these loans to borrowers with FICO scores lower than 600. Unbelievably, we're even lending billions (more than $3 billion, actually) to folks with FICO scores less than 540.

It seems implausible to me that these loans will work out for us in the end. By the end of 2012, nearly $1 billion of these loans was already in default. Just imagine what will happen to these weak borrowers when we eventually enter another recession. Just as our sales are declining, all of these bad debts will come due. All the repossessed cars will flood the market, driving down recovery values and destroying demand for new cars.

Haven't we learned anything from the last financial crisis? Apparently not.

You will see as we move forward, our margins will continue to decline because of the global problem of overcapacity. Charities – which is what all of the major car companies have become – don't make a profit. As our margins decline and our cash flow disappears, the union and retiree demands on our remaining capital resources will grow more intense. We'll have to borrow more and more simply to fund our pension obligations.

We will also be borrowing, massively, from Wall Street to finance our car buyers.

Sooner or later, we will end up losing money on every transaction, while trying to make it up on volume… and financing that volume using our own balance sheet.

It's insane… unless you understand it's my only hope. I've got to borrow billions and billions over the next few quarters. I've got to scale up, so that we're so big we can't be allowed to fail. It will be the same madness we saw in 2008 all over again.

But this time, it won't take decades to unravel. It will happen much faster. My guess is within five years, we'll be in a crisis again. And our stock, which is currently valued at $50 billion, will be worth nothing.

Please invest accordingly.

Best regards,

The Chairman of General Motors